Wrong investments can derail your goal achievement

Abdul Rasheed is 32 years old and lives in Hyderabad with family. He works as a engineer in a private company. His take home salary is Rs 40,000/pm. His philosophy is 40 per cent of salary should be set aside for household and personal expense and 60 per cent should be saved. He pays Rs.8000 as home loan EMI. He has to pay it for 10 more years. He is depositing Rs.5000 every month in a post office savings account for 5 years. He has 2 life insurance policies of Rs1.80 lakhs and Rs.1.25 lakhs and pays Rs.3000 as premium. He pays about Rs.1000 towards Mediclaim. His family expenses are about Rs.13000. He saves about Rs.10000 in a savings bank account every month.

Let us analyse the financial situation of Abdul Rasheed

.His expenses are about 32.5% of his Income. He is well in control of the expenses. He should see that expenses do not go beyond 35% of his income in the future.

His loan repayments are about 20% of his income. Ideally the loan repayments should be kept under 35% of the income. So, his loan repayments are well within the ideal limits.

He spends about 10% of his income towards insurance premium payments. The insurance premiums should be limited to 10% of the income. So he is OK with that. But his life insurance coverage is just Rs.3.05 lacs only.

He is working in a private company. In his absence his family will not get any pension benefits. So he will require life insurance cover equal to 10 times of his annual salary just to support his family’s expenses in his absence. Apart from that he will require cover against his outstanding liabilities and also to meet life goals in his absence. A Rs.40 lacs term cover would have costed him about Rs.9800 per annum which is about Rs.817 per month. Traditional Life Insurance policies, as a means of long term savings is not a good idea since the returns are found not good enough to cover inflation. He is paying about Rs.12000 per annum towards mediclaim policy. He might be having medical insurance cover of about Rs.3 lacs which is good considering his situation.

It seems that he has not identified his goals. He is currently saving about 37.5% of his income. But for what? There should be a purpose for saving. He may work for another 28 years. After that he may be living till 85 years of age without income. He will require to accumulate enough money in 28 years that will help him pay for his expenses through the retirement period.

Retirement is one goal. He has to set his other goals also. He has to state which year how much money is required for which purpose. For e.g. for higher education of the son, he will need Rs.10 lacs in today’s value after 16 years. If he has some assets that can be allocated to the goal, he should do it. After that if there is a shortage then he should identify how much he is required to save every month to cover the shortage by the time the goal is reached.

He is currently saving in post office deposit and savings bank. This is good for short term goals, but the returns are low. He needs to keep only about 3 to 4 months expenses plus loan repayments in a bank account as emergency fund. Rest of the assets he has to deploy in high yielding asset classes based on the time horizon of each goal and his risk tolerance ability.

Asset classes like equity will give high returns in the long term. The risk is also low in the long term for these asset classes. But in the short term they carry very high market risk. Assume that one invests 100% in equity for a long-term goal like retirement after 28 years. Equity has historically given high returns always for longer periods. But if his risk tolerance ability is lower, he will get worried when he sees short term fluctuations and may redeem all investment at a loss. So, it is better to allocate assets over lowly-correlated asset classes which will reduce the short-term risk considerably without compromising much on the returns.

Abdul Rasheed was suggested to get a Comprehensive Financial Plan prepared. A financial plan will help him set his goal, allocate his investments and start savings plan that will help him achieving his goals.

It will also help you to review your insurance policies and help with advice on your life insurance requirement. It also helps you with advice on controlling expenses and managing your loans.

PrognoAdvisor.com is a SEBI Registered Investment Adviser Company and does not sell any products. Its unique advisory process which combine cash flow planning and goal planning ensures that the plan is practical.